This week, the market continued to focus on the US Federal Reserve and its next meeting taking place June 14-15. The odds of an interest rate hike were increasing until we got Friday’s employment report which showed the lowest job creation in 5 years. The odds of an interest rate increase at the June Fed meeting as measured by futures dropped from a 30% chance last week to 4% this week.
Gold, which had been falling over the last several weeks spiked on the news. Financial stocks, which benefit from higher interest rates, fell.
Here is a 2 year chart of oil which has stabilized and recovered from the low set in February. Oil fell slightly this past week to $48.90 a barrel well off the low of $26.05 set in February of this year. Higher oil prices bode well for earnings in the energy sector for the second half of the year.
Here is a 2 year chart of the US dollar. After a dramatic rise in 2014 and early 2015, the dollar has been trending down, especially since February 2016 which makes US exports cheaper and this also bodes well for earnings in the second half of the year. After rising the last several weeks on anticipation of a Fed rate hike, the dollar fell hard on Friday’s weak employment report.
Finally, here we see a chart of leading economic indicators (blue line). Leading indicators on the rise indicate the economy is expanding in the future, declining leading indicators might point to a future recession. The red line represents coincident economic indicators which are also on the rise and indicate we are not currently in a recession. As you can see from the blue line, leading indicators continue to trend up and I believe the risk of a recession is still low. Recessions tend to be associated with big market declines.
Here is how market indices fared as of Friday 6/3/2016.
Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing.
Below is a two year chart of the S&P 500, an index of the largest 500 publicly traded companies in the US. After 3 dramatic corrections in September 2014, August 2015, and January 2016, the S&P 500 is again near 2100. We have had a tough time getting past this level as you can see from the chart and have been stuck in a choppy, sideways, range bound environment for the last 2 years. Where will the market go from here?
The market doesn’t like uncertainty and areas that are not clear include the upcoming British vote to exit the European Union, the US Federal Reserve and its interest rate policy, the US Presidential election, the struggling Chinese economy, and most importantly corporate earnings in the 2nd half of 2016. Earnings, are estimated to increase 14% in 2017, but this is far from certain (Source: Factset). The Price to earnings ratio of the market is now 24, which is about average over the last 35 years meaning stocks are basically fully valued until we see earnings increase.
On a more positive note, the economy continues to plod along with low odds of an immediate recession as shown by leading indicators (Source: Conference Board). Crude oil has improved and the US dollar has declined which should alleviate some of the earnings drag. There is bipartisan support for tax reform with an estimated $2.1 trillion in cash of US companies parked overseas (Source: Bloomberg). Eliminating the incentive to hold cash overseas could be a boost to the US economy. Finally investor sentiment is very low and this can be a positive contrarian indicator (Source: AAII).
It will be interesting to watch it all unfold.